Opportunity Zones - new potential PERMANENT tax savings?

59 Replies

Hi Everyone,

As a CPA who specializes in real estate I have been doing some reading on the new Opportunity Zones (OZ) passed effective 1/1/18 with the new tax law. While guidance is still a bit unclear and more research has to be done I think this is a huge opportunity for real estate investors to have permanent tax savings (along with other benefits) - even better than a 1031 exchange!

From what I understand here are some key benefits of the Opportunity Zones:

 - Permanent gain exclusion on the appreciation of investments in Opportunity Zones 

- Deferral and reduction of capital gains used to invest in Opportunity Zones. I believe this is deferred until the investment is sold or 12/31/2026, whichever comes first. (this is the capital gain used to fund a deal in an OZ, not the appreciation on the investment). There are additional rules for holding it less than 5 years (100% deferred gain recognition), 5-7 years (90% deferred gain recognition), and > 7 years (85% deferred gain recognition).

- Any depreciation taken on the investment in the OZ is permanently saved and NOT recaptured if held for 10+ years. This is big and combined with the gain exclusion is essentially a double dip of tax savings!

Other items to consider:

- Income or loss from operations in an OZ is taxed normally

- An OZ is a lower income census tract designated by each states Governor. The zones have already been established. I have looked into the zones around the Twin Cities (Minneapolis & St. Paul) and Minnesota as that is where I live. If other investors have looked into zones in their local areas, feel free to chime in.

- I believe eligible investments in OZ's are real property, operating businesses and equipment. 

-However note that for real property the original use must be with the taxpayer or it must be substantially improved i.e. new construction or a major renovation - it does not look like turn key properties would qualify. The point of the law is to improve certain areas of the country by bringing in new structures and upgrades.

I will be doing more research and talking to additional real estate specialists at our firm for more guidance. Again this is just my best understanding of the current law, there is still a lot more guidance needed for OZ investments.  If anyone has additional info or guidance or sees something in this post that is incorrect please share!

Overall this could be a HUGE benefit for real estate investors and definitely something to consider. The potential for permanent depreciation savings, appreciation savings and reduction of capital gains could be very significant.

I can also run through a hypothetical example if it would be helpful.

Updated 10 months ago

Update: It sounds like depreciation recapture may still be taxed (pending further guidance), however the appreciation tax-free savings would still be available.

All:

There is supposed to be additional guidance coming out this fall from the Federal Government and MN DEED has a section on their WEB site dedicated to this topic as well.  Two census tracts in West St. Paul (which is most of the community) have received the OZ designation with a third tract in South St. Paul (the only three in Dakota County) and of course there are others spread around the TC metro (full disclosure, I am associated with these communities). As more info comes out the cities will be interested in increasing awareness of these investment opportunities.

Glad you are posting about this, I’m also just learning about the benefits of opportunity zones and looking to structure a deal I have under contract in an opportunity zone in Kansas City, MO to take full advantage of the benefits.

Hi Austin. I would be interested in connecting with you. I am a Twin Cities investor who has been looking into this and actually identified a zone my partner and I are considering for investing. As I understand it, you need to improve the property by at least 100%, which means build or major renovation. We are considering building a fourplex in the zone we have identified if we can find the right lot or tear-down opportunity.

I am also a CPA and have been researching the new law as well as looking into and discussing its potential use with other parties. It is indeed very interesting and Austin does a great job explaining it.

One thing I will add is that the “substantial improvement” part of the law - aimed at development / redevelopment - is especially interesting because you can do a cost segregation study / bonus depreciate parts of your property in connection with meeting the substantial improvement stipulation. With bonus depreciation now at 100% for certain business assets, you can recognize very nice up front savings and meet the QOZ qualifications while performing a build out for the tenant.

Investors can search “[Insert State] Opportunity Zones Map” and I believe most, if not all states, have a website set up with a listing of all designated zones as well as a GIS map that shows all of the zones in your state. This has worked in all of the states I have tried so far.

If anyone would like to discuss more, feel free to message me, I’d be happy to talk and bounce ideas off others. Hopefully we get more IRS guidance soon as well, as we are in a bit of the Wild West currently in regards to that.

@Daniel Kurkowski I believe the improvement must be double the basis in the property (i.e. buy an apartment building for $300k, and then put another $300k into it) - Note that the investment must be made in a qualified OZ fund as well which are self-certified and can be any partnership that holds at least 90% of assets in qualified OZ property.

I looked into this quite a bit a couple months ago as the city I live in is included.  I think it could work well in certain situations but whether this is enough incentive to build in certain areas is unclear.  May be a better play for developers/syndicators who can offer some tax protection to individuals looking for long-term investments.  These zones are based off of income - I haven't thoroughly looked at the zones in MN but suspect you aren't going to find any A locations which will be a concern for wealthy individuals.

For those in MN interested here is a listing of the opportunity zones: https://mn.gov/deed/business/financing-business/tax-credits/opp-zones/census-opp-zone-tracts.jsp

@John Woodrich I also agree the zones will not be for everyone. I am thinking developers/operators and some funds/institutional money will be big players in these zones, although if smaller investors can find big enough value add opportunities there could be the potential for some big long term savings.

Interestingly enough it appears that the Mall of America is smack dab in the middle of one of the OZ's. Granted the zones will not be "A" locations but some of them seem to be fairly decent. 

I think these zones have the potential to be the biggest tax incentive since the New Markets Tax Credit - the potential tax savings could be enormous.

This is an extremely interesting new wrinkle in the tax code. The forthcoming guidance on this will be very helpful, and by first glance it looks like a huge benefit for savvy investors. Using cost segregation and 100% bonus depreciation in tandem with the OZ seems like a no brainer, but the opportunity for using cost seg’s “little brother” an abandonment study would be perfect for this. An Abandonment study is basically the same as a cost segregation study, but it’s done on a property that will be torn down. You get all the benefits you’d normally get from cost seg, but there’s no recapture since the assets are immediately retired through demolition. Then you build the new property and do cost seg on the new assets as you’d normally do. Done right it’d be a windfall tax benefit and you’re doing your part to revitalize the area! The more I learn about the new tax law, the better it gets for real estate investors.

Was out of town on vacation so haven't been able to comment.

@Austin Hendrickson the New Markets credit is huge for certain people and often overlooked.  As it sits right now I don't think there is language out there precluding someone from getting New Market Credits and qualifying for an OZ.  That could be huge depending how the final language reads.

@Michael Plaks nice article on 1031 v. OZ.  Before getting on here responded to a messaged saying that this may be an option for someone who fails to meet the identification period for a 1031 but if someone has a large gain they may also have a large amount of recapture...  At that point something is better than nothing though!

@Lee Ripma - you had some good questions on OZ's and I think adding them here would be helpful

Q: Can I 1031 capital gains (just the initial capital gain contributions) at 12/31/2026?

A: No. The 45 day and 180 day requirement would not be met as those are on properties sold today. So at 12/31/2026 the capital gains from the initial contributions would have to be recognized. The capital gains for 10+ years would still be tax free.

Q: Does the "significant renovation" piece have to be from capital gains as well?

A: Yes. All contributions into the fund must be capital gain. If there are cash contributions it will dilute the tax benefits. So the renovations would have to be financed through capital gains or through a loan. So for example buy an apt for $200k, put $200k into it that would qualify. If you put down $60k capital gains and the bank finances the rest that would potentially qualify for all of the tax benefits.

Q: If I hold property in an OZ for less than 5 years are there any tax benefits?

A: No. If held less < 5 years no tax benefits. 5-7 years = 10% initial capital gain reduction. 7+ years = 15% initial capital gain reduction. 10+ years = completely tax free appreciation and depreciation along with the 15% initial capital gain reduction.

I have seen many questions on the proposed opportunity zone regulations and the self-certification form.

Well as of today the IRS has issued guidance!

The IRS has just issued updated guidance on OZ's including the draft self-certification form (Form 8996).

From a quick high level glance at the newly issued 74 page draft regulations it does appear that only capital gains will qualify (which confirms the position our team held) 

Our real estate team will be diving into this over the weekend and next week in more detail.

Thanks for the info @Austin Hendrickson.

I have several properties located in OZ's in Oakland CA already.  One of the properties I'm getting ready to build a second free standing house on, making it a duplex (2 houses on 1 lot).  

Looking at this tax law, I'm thinking of selling another house that has tripled in value and using the capital gains from that house to fund the construction of the 2nd unit.  That way I cash out the one house and use the taxes I would of paid to fund my project.  Does this logic generally make sense with your understanding of the law?

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